5-year Rule

Submitted by Mark Strong on Sat, 2016-06-04 19:37

My question is about the so-called “5-year rule.” Not the one for a Roth IRA being held for 5 years. I’m confused about the one applying to a non-spouse inheriting a Traditional IRA, Roth IRA and perhaps even a 401k or 403b.

For the sake of this question, assume a 50-year-old non-spouse is the sole beneficiary and inherits a 20-year-old Roth IRA from a 72-year-old original owner. My understanding is they must start to take required distributions from the inherited Roth IRA by December 31 of the year the original owner died. Those distributions amounts are calculated based on their own life expectancy, not that of the original owner.

Now, that person may also choose to delay taking the required distributions for a period of 5 years. At the end of that 5 years, which one of the following is the correct interpretation of the “5-year rule?”

A – They must start to make annual withdrawals based on their own life expectancy. Failure to do so would result in a penalty. Or………

B – At the end of the 5-year period they must withdraw the entire inherited amount all at one time or incur a penalty. Or……..

C – None of the above

Finally, would the same required distribution rules also apply to a non-spouse inheriting a Traditional IRA, 403b or 401k in regard to this “5-year rule?”

Thanks for any help on this issue.



Submitted by Alan - IRA critic on Sat, 2016-06-04 23:03

  • The 5 year rule only applies to beneficiaries if the owner passed prior to the required beginning date with respect to a TIRA. Because a Roth IRA does not have a required beginning date, all deaths are prior and the 5 year rule can be used regardless of the age of the Roth owner at death.
  • Under the 5 year rule, no amount  is required to be distributed in any year, the only requirement being that the account is drained by the end of the 5th year following the year of the owner’s death. Note that the year of death is not counted as one of the 5 years. Before the final year, the beneficiary can take out any amount they wish, but draining the account by the end of the period is the only requirement. While your answer B is close to correct, the amount does not have to be distributed all at one time, so any remaining amount needs to be distributed by the end of the period. The same rules apply apply to a TIRA and employer plans except that the 5 year rule cannot be used at all when the owner passes on or after the required beginning date.
  • The default rule is life expectancy, so the 5 year rule must be elected. It may be best to start with life expectancy since the beneficiary can always take out more in any year. The 5 year rule is only beneficial in certain unique circumstances such as when the LE distributions in the first 5 years  would occur when in a high tax bracket but the final year the beneficiary is in a very low tax bracket, if LE is not much longer than 5 years, or if the IRA is invested in illiquid investments.

Submitted by Mark Strong on Fri, 2016-06-10 18:53

Can the non-spouse inheriting the Roth IRA choose to withdraw the account based on their own life expectancy as long as they begin the withdrawals by December 31 of the year the original Roth IRA owner died?  If they fail to do so in that year, then and only then will they have to withdraw all the funds in the account at the end of the 5 year period.

Submitted by Alan - IRA critic on Sat, 2016-06-11 00:07

The non spouse beneficiary is not required to take a life expectancy RMD until the end of the year FOLLOWING the year of death. No distribution is required for the year of death. And even if the beneficiary fails to take a life expectancy RMD by the end of that next year, almost all IRA agreements use life expectancy as a default. The IRS has ruled that if the beneficiary misses an RMD they can make up the missed RMD when discovered and continue to use their own life expectancy. While they may owe a penalty for the missed year, there is also a good chance that if they appeal the penalty using Form 5329, the IRS will waive it. In summary, if the RMD for a year is missed, it does not mean that you triggered the 5 year rule.

Submitted by Mark Strong on Tue, 2016-06-14 17:01

Perhaps I’m not being very clear with my question and am causing confusion.  I’m asking about a non-spouse inheriting a Roth IRA only.From what I understand the inheritor must begin to take the life expectancy RMD annually based on their own life expectancy from the account by Dec. 31 of the year after the year in which the original owner died. If they don’t make the RMD by that deadline, they will need to have withdrawn all the assets by the end of the fifth year after the year of death.In short, that failure to begin by the deadline is what “triggers” the 5-year rule requiring the account to be completely emptied by the end of the five years.Do I now understand this 5-year rule correctly?Thanks for your patience and help with my concerns.  I really appreciate it.

Submitted by Alan - IRA critic on Tue, 2016-06-14 18:00

  • As indicated earlier, if the non spouse beneficiary misses their first life expectancy RMD, that does not mean that they are stuck with the 5 year rule unless they want to use that rule. The IRS has issued letter ruling PLR 2008-11028 allowing the beneficiary to make up the late RMD and then continue with life expectancy RMDs. In the PLR, the taxpayer had to pay the 50% excess accumulation penalty due to the late RMD, however I think if the beneficiary requests a penalty waiver on Form 5329, there is a good chance the IRS will waive the penalty.
  • It is true that the IRS noted in the ruling that lilfe expectancy must be the default rule in the IRA agreement for the ruling to apply. However, almost all IRA agreements do use LE as the default provision for beneficiary RMDs so it is highly unlikely that an agreement would make the 5 year rule the default provision and place a time deadline to opt for life expectancy instead.

Submitted by Cue Orr on Fri, 2019-01-04 18:16

My mother passed on 2/29/12. At the end of 2017 I found out that i needed to eventually do something with the money and I heard about the 5 year rule. In attempt to get it rolled over I rushed to have it processed but was told that the money would not be forced out of the account at the end of the 5 years  and I could roll it over the follwoing year 2018 and take my RMDs aswell as workout any penelties with the IRS.  As I decided to move forward with this rollover in December 2018 I was denied the trustee to trustee rollover becasue they said I missed the 5 year rule after i was told previously that i would be able to roll it over. What are my options?

Submitted by David Mertz on Fri, 2019-01-04 19:05

inheritedissues, was your mother’s date of birth prior to 7/1/1940?  If so, the 5-year rule does not apply because she died after her required beginning date for RMDs.

Submitted by Alan - IRA critic on Fri, 2019-01-04 20:08

  • For the moment, let’s assume that mother did pass prior to her RBD and the 5 year rule is therefore in play. Rarely discussed is the effect of the IRA agreement provisions requiring the beneficiary to make an election by a certain deadline. Almost all agreements do use life expectancy of a designated beneficiary as the default, but vary in how an election is to be made out of life expectancy.
  • Vanguard’s agreement indicates an election of the 5 year rule can be made but is vague regarding when or how the election is made. Possibly, VG considers the election to be deemed made the first time a LE RMD is not completed.  Effect of PLR 2008 11028 is not addressed.
  • Schwab’s agreement requires election of the 5 year rule to be made in writing by 12/31 of the year following the year of death. Otherwise, LE is deemed to apply. PLR 2008-11028 could then be applied to make up late RMDs.
  • Fidelity – same as Vanguard plus indicates that a full distribution will be made at the end of the 5 years.
  • None of the agreements address direct transfers, but if the 5 year period was deemed elected, refusal to do a direct transfer after the periods ends seems consistent. A distribution would obviously eliminate PLR 2008-11028 as a later option.

Submitted by Cue Orr on Wed, 2019-12-18 07:21

Thanks for your previous reply. So my mother did pass prior to her RBD and the 5 year rule was in play. I have battled all year to be able to get the direct rollover but I havent been able to get the decisoion over turned. The Money is currently still in the account and it is looking like my only option is to take the full payout. When I spoke to them last they said that they werent going to force the payout. I’m just Not sure if any one has any other advise on how to handle this.

Submitted by Alan - IRA critic on Wed, 2019-12-18 15:46

Under the 5 year rule, the inherited IRA (TIRA or Roth) must be fully distributed by 12/31/2017 (Death in 2012). However, as of 1/1/2017 no portion of the inherited account is eligible for rollover per Notice 2007, QA 17.  That was 3 years ago. At this point you need to take the full distribution and file Form 5329 for 2017 and 2018 to request that the penalty be waived for reasonable cause. The IRS typically will approve the waiver. If you do not take the full distribution by year end, you will have to file a 5329 for 2019 as well.  I don’t know why they are telling you that you can leave the account there when you face potential huge penalties from the IRS if they do not waive them.

Submitted by Cue Orr on Thu, 2019-12-19 01:27

Appreciate your insight, Is there a resource that shows how to fill it out a 5329 properly? 

Submitted by Alan - IRA critic on Thu, 2019-12-19 02:10

https://www.irs.gov/pub/irs-pdf/i5329.pdf

Submitted by David Mertz on Wed, 2019-12-18 16:34

  • I think that was meant to say Notice 2007-7 Q&A 17.
  • The original question posted at the top of this thread was about an IRA inherited from the decedent.  Although inheritedissues refers to doing a direct rollover, I’m not sure if inheritedissue’s situation actually involves mother’s account being an account in qualified retirement plan or if mother’s account was actually an IRA and the term “direct rollover” was used inappropriately.  If it’s an IRA and the IRA agreement does not make the 5-year rule the default, I don’t see why the account could not be trustee-to-trustee transferred (not rolled over) to an inherited IRA for inheritedissue’s benefit, late annual beneficiary RMDs for 2013 through 2018 made and requests for waivers of excess contribution penalties be made, thus restoring the stretch.  Unfortunately, though, PLR 200811028 deals with restoring the stretch before the end of the 5th year following the participant’s year of death, so it doesn’t entirely parallel inheritedissue’s situation.
  • If mother’s account was an account in a qualified retirement plan, yes, the only option at this point is a full distribution.

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